Trade Picture: February 13, 2004

Soaring imports from China push U.S. trade deficit to new record

The U.S. Department of Commerce today reported that the merchandise trade deficit reached a record level of $549 billion in 2003, an increase of 14%. The aggregate U.S. trade deficit, which includes both goods and services, was $489 billion, a 17% increase. Growth in the trade deficit reflects surging imports and the declining competitiveness of U.S. manufacturing industries. The merchandise deficit as a share of U.S. gross domestic product (GDP) increased to an unprecedented 5% in 2003.

The U.S. trade deficit poses great risks for the economy. To finance its trade deficits, the United States must borrow abroad. The recent decline in the dollar indicates that private foreign lenders are less willing to supply new credit. Foreign governments have been forced to step into the gap and finance a growing share of U.S. international debt. A rapid, uncontrolled decline in the dollar could push the U.S. economy into a sharp recession. In his testimony before the House Committee on Financial Services on February 11th, normally circumspect Federal Reserve Chairman Alan Greenspan acknowledged this risk: “…given the already substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents.”

The 6% annual decline in the real value of the U.S. dollar since 2002 probably starts the process of reducing the trade deficit in the future. As the dollar declines, it makes U.S. exports cheaper in many foreign markets and makes foreign imports to the United States more expensive. In 2003, the dollar fell much more against the euro (41% in nominal terms) than other currencies. Asian nations, in particular, engaged in heavy intervention in foreign exchange markets in order to prevent the dollar from falling against their currencies.

China’s trade surplus with the United States increased 20% in 2003 to $124 billion. China has refused to increase the value of its currency, resulting in an expansion of the trade gap. China’s intransigence has also made it more difficult for other Asian nations to allow their currencies to rise. The U.S. trade deficit with China is now the largest it has with any country in the world. Imports from China are now 5.7 times the value of U.S. exports to China, making it the United States’ most imbalanced trading relationship. About 98% of Chinese imports to the United States were manufactured commodities. Some of the fastest growing imports included information and communications technology equipment (an increase of $9.5 billion in 2003), electronics ($107 million), and aerospace products ($25 million).

The U.S. trade deficit with the Pacific Rim increased 7% in 2003, reflecting deep changes in the structure of trade with Asia. The U.S. deficit with Japan fell 6%, but Japan’s global trade (current account) surplus increased by 12%. Increasingly, Japan and other newly industrializing countries in Asia are exporting their component products to the United States through low-wage assemblers in China, Mexico, and elsewhere in Latin America.

The U.S. deficit with Western Europe rose 14%. This increase probably reflects the higher prices of European Union exports caused by the sharp appreciation of the euro more than it reflects an increased volume of imports from the EU. The deficit with Europe should begin to fall in 2004. The small U.S. deficit with South and Central America rose sharply in 2003, reflecting the lingering effects of the financial crises of the late 1990s and the globalization of export supply chains.

The gain in the real value of the dollar between 1995 and 2002 helps explain the rapid growth of the U.S. trade deficit results. The dollar began to rise significantly in 1997 and peaked in 2002. It usually takes five to six quarters for the trade balance to respond to a change in the value of the currency. The real value of the trade deficit as a share of GDP reached a peak in mid-2003. The dollar, however, must fall much more to help the trade deficit reach a sustainable level.

A 30% fall in the dollar from 1985 to 1988 was required to reduce the real trade deficit from about 2% of GDP to 1% of GDP by 1989. The dollar stayed down in that range through 1997, and the deficit stayed around 1% of GDP (except when the recession of 1990-91 pulled the deficit down to zero). To bring down the 2003 deficit of 5% of GDP will require a much larger devaluation of the dollar. U.S. imports are almost 50% larger than U.S. exports. Thus, a tremendous increase in industrial output will be needed to close the trade gap.

Rapid growth in the goods trade deficit was explained, in part, by large increases in both the price and volume of natural gas and petroleum imports. The balance of trade in agricultural products was essentially unchanged in 2003.

Manufacturing lost 582,000 jobs in 2003, and 3.3 million manufacturing jobs have been eliminated since December 1997. The real value of the trade deficit has nearly tripled in this period, which explains a large share of the job losses in manufacturing. The U.S. deficit in manufactures rose from $430 billion in 2002 to $471billion in 2003 alone, an increase of 10%. Job losses have also expanded because of the recent U.S. recession and continued growth in productivity, which is strongly associated with intense import competition.

Of particular concern is the large and rapidly growing U.S. trade deficit in high technology products. This deficit rose nearly $11 billion in 2003, a 65% increase, led by a decline in aircraft exports and a sharp increase in pharmaceutical imports. The inability of U.S. firms to compete in the high-tech sector reflects deep, structural problems in domestic manufacturing industries and the inflated value of the U.S. dollar.